Page 55 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 4 : Modern Theories of International Trade : Theorem of Factor Price Equalization, H-O Theory, Kravis and...

country must be abundant in capital supply; and if labour is relatively cheap in the other country, it Notes
must be a reflection of the labour abundance in that country.
It now remains for us to show that one country, say country A, is capital abundant and it exports
capital-intensive good, and the other country, say country B, is labour abundant and, therefore, it
will export labour-intensive good. We shall examine these Heckscher-Ohlin proposition by using
both the definitions of factor abundance—not together but separately.

Price Criterion of Factor Abundance
Starting from the definition of factor abundance in terms of factor prices, it is easy to establish the
Heckscher-Ohlin theorem. It is easily demonstrated in the succeeding diagram.
The two factors—capital (K) and labour (L) are measured along the vertical and horizontal axis,
respectively. The set of factor price ratios in country A, a capital surplus country, are shown by the
parallel lines P P . The relative steepness of these lines reflects the fact that capital is cheaper and
0
0
labour is dearer in country A. Similarly, the lines P P reflect the factor price ratios in country B. The
1
1
relative flatness of these lines shows that labour is cheap and capital is expensive in country B, a
labour surplus country.
Then we have the two isoquants labelled aa and bb, and the two isoquants cut each other only once,
i.e. at point Q. This indicates that there is no reversal of factor intensity, meaning that one commodity
is capital intensive in both the countries (K good represented by the isoquant aa) and other commodity
(Good represented by the isoquant bb) is labour intensive in both the countries. This is in conformity
with the Heckscher-Ohlin assumption that the production functions are identical for each good in
the two countries.

P 0

P 0 a
b
F H J
K (Capital) P 1 1 Q

P

R
N b
M K-Good
T a
L-Good
O D E P P 0 G P 1 P 1
0
I (Labour)

Figure 4.7 : Price criterion of factor abundance.

We can now see how the capital surplus country would export capital-intensive good, and labour
surplus country would export labour-intensive good. Take country A first. The cost of producing one
unit of K good is made up of HD amount of capital plus HF amount of labour, because at point H
there is a tangency between the isocost curve and the isoquant for K good. The cost of producing one
unit of L good consists of JE amount of capital (which is equal to HD) but more labour viz. FJ amount
of labour (as against FH amount needed to produce one unit of K good). In other words, in country
A, in order to produce one unit of L good, you need to use the same amount of capital as in K good

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